Users says yes, academics says maybe

As one of the most popular development tools during the latest decades, there are not surprisingly a vast body of academic literature that discusses the impact of microfinance. Most of the earlier studies find evidence that microfinance have positive impact on incomes and living standards and hence reduces poverty. There are also studies that supports that programs directed to women, in addition to increase incomes, have positive effects on women empowerment. However, some later studies questions these results and argues that the positive effects of microfinance have been overstated. In turn, these studies have been criticized, among other things for only studying loans and not taking other services offered by MFIs such as savings or financial training into account.

It should be noted that it is very hard to measure the impact of interventions such as microfinance. Probably, this is why it seems impossible to reach consensus regarding the effects. To be able to clearly state that an improvement in for example income is caused by the access to microfinance, the development in areas with access to microfinance must be compared over time with a very similar area that has not had access to microfinance. This can be done for example by randomizing in which order a microfinance program is rolled out to different areas and study the effects (often called randomized controlled trial, RCT). Still, it is difficult to make sure that the only difference between the areas is the access to microfinance. In addition, potential effects of microfinance are complex and difficult to measure.

Another way of measuring the effects of microfinance is through let users of the services “vote with their feet”. By looking at the quick growth of the microfinance sector and the high repayment rates, it seems clear that microfinance is valued by the clients. Studies show that borrowers prioritize to repay MFIs over other lenders when they experience problems with repaying debts to secure future access to MFIs services. They are also willing to pay a high price in terms of interest rates for using them.

Microfinance is no magic bullet that in itself eliminates poverty, but on the other hand, it seems hard to find any general negative effects.

To summarize, we can conclude that although microfinance most eager supporters do not find support for their claims, also the critics have to struggle to back up their arguments. Microfinance is no magic bullet that in itself eliminates poverty, but on the other hand, it seems hard to find any general negative effects. The general consensus about most development and poverty reduction tools tend to be that if they are used in the correct way, they are beneficial, but if they are used wrongly they are not and this seems to be true also for micro finance. Microfinance is clearly not for everyone. For those who are ambitions and business minded, access to credit might be what is missing for developing their small scale businesses into success. But for those who lack ambitions and business ideas, access to credit is unlikely to change that.

However, the real beauty with microfinance lies in two things. The first is that even if not all microfinance programs have succeeded in their mission of reduce poverty, they help people to cope with poverty. The second is that microfinance, in comparison to other forms of poverty reducing interventions, is extremely cost-effective since it is a way of recycling aid.

Microfinance helps people cope with poverty

Poor households often experience large fluctuations in income and sudden needs for emergency resources. Since these households rarely have any savings, they become very vulnerable to financial and economic shocks. Small scale businesses are seldom separated from the household economy. For microenterprises ran by poor households, the lack of household savings therefore often forces them to use business capital to meet household consumption expenditures during periods of low income flows or as a result of emergencies.

Loans given to expand businesses can sometimes be used for large lump sum expenses such as school fees. Still, this is beneficial for the user. 

Access to financial services, including credit and insurance, can play a vital role in ‘smoothing’ income flows and provide poor households with other opportunities for handling sudden expenses than deplete their working capital. Thereby, access to microfinance can be said to substantially reduce the vulnerability to financial and economic shocks for poor. According to a study by the Asian Development Bank (1997), the provision of financial services to the poor can be regarded as a worthwhile service in its own right. Money fungibility – borrowers using the loans for other purposes than they were supposed to, is of less importance. If part of the loan finances consumption rather than production and hence provides asset protection rather than asset creation, this is still preferable to asset loss. Borrowers may also use microfinance loans to settle debts with higher cost informal lenders, thus securing a reduction of their interest costs. In other cases, microfinance loans may finance lumpy expenditures for education, emigration or housing which often offer long term returns that are comparable to investment in microenterprises. Loans may also be used for informal on-lending, which could increase competition and lower informal lending rates.                  

Microfinance is a way of recycling aid

Microfinance compares favorably to other poverty reducing interventions particularly with regard to cost effectiveness and prospects for sustainability. Donor investment is recycled and reused and unlike many other interventions, costs for microfinance tend to diminish with the scale of outreach. Regarding the issue of sustainability, it can be said that few, if any, other development tools have the potential to become sustainable to the extent that this is possible in microfinance, where after initial start-up grants, new inputs are not required for every future client. Today, many MFIs that initially was started as NGO or government projects have become independent of their funding and profit-driven companies have entered the market.

Learn more:

Learn more about the positive impact of microfinance in these papers published by CGAP, Consultative Group to Assist the Poor

Littlefield, R., Morduch, J., & Hashemi, S. (2003). Is microfinance an effective strategy to reach the millennium development goals?  Focus Note No 24 2003, CGAP.

Rosenberg, R. (2010). Does microfinance really help poor people? Focus Note No 59 2010, CGAP

A more critical view on microfinance is provided in this article:

Banerjee, A., Karlan, D., and Zinman, J. (2015). Six Randomized Evaluations of Microcredit: Introduction and Further Steps. American Economic Journal: Applied Economics 2015, 7(1): 1–21

Find summaries of and links to recent RTC studies on microfinance here:

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